Different Corporate Types and What You Need to Know
All types of corporations and LLCs give you the same excellent liability protection but one basic difference is how profits are taxed.
LLCs and Sub-S Corporations
All company profits (income after expenses are deducted) will be forwarded to and taxed on your personal IRS form 1040. Generally (check with your tax advisor) if both your income and the company’s profits together are less than $500,000, you will pay a slightly less tax rate with an LLC or Sub-S. HOWEVER, if corporate tax rates are lowered as is being suggested, this figure will drop dramatically and be more in the $50,000 area and a LLC and Sub-S corp would be at a huge tax disadvantage on higher earnings unless the personal rates are also lowered.
Losses in LLCs and Sub-S companies are likewise forwarded to your personal 1040. This can be an advantage when starting out and your company has losses that can be deducted against your regular income. If you live in a state with personal income taxes, you company income will be taxed in your state also.
Regular and Close Corporations
All income and loss is reported on the corporate tax return and pays corporate tax rates. It is totally separate from your personal 1040 form. This can be a disadvantage when income is low or at a loss but can be beneficial when income is high. This will be a huge advantage if corporate tax rates are dropped to 15% – 20% area.
What to do with an LLC or S corp if corporate rates drop below your personal rate.
There is a simple fix if regular corporation rates drop to 15%. A Sub-S corporation is just a regular corporation that has asked the IRS to be treated tax wise as a LLC or partnership. All is needed is to ask the IRS to drop the S designation and it becomes a regular corporation. LLCs can also be changed to regular corporations but not as easily. We have changed several LLCs to corps so give us a call if you need to change.
Below is more specific information.
The C-corporation is the most commonly formed corporation. It is great for building credit separate from individual credit and limiting individual liability. The corporation is a legal separate “person” which may live forever and be passed down from generation to generation. It protects the shareholder from any adverse actions the corporation may encounter. Just as an individual it can own assets, borrow money, mortgage its assets, and file bankruptcy. Shareholders elect a board of directors and officers to manage the corporation. Wyoming allows one person corporations where you can be the only shareholder who is also the director and officer.
- Limited liability–no shareholder; director or officer may be held liable for debts of the corporation unless corporate veil was pierced.
- Credit building–corporations build credit under their own EIN number totally separate from shareholders.
- Capital raising–corporations may sell common or preferred stock, issue bonds, borrow money, mortgage assets. There is no limit on the number of shares issued.
- Legal agreements–corporations may enter into contracts and legal agreements.
- Continuity of life–the entity exists forever so long as corporate regulations are met. No need to dissolve the corporation if an owner or manager dies.
- Ease of ownership transfer–the assets may be sold, transferred, pledged, or mortgaged simply by using stock.
- Income is taxable to the corporation and not shareholders.
A Wyoming corporation pays NO state income tax.
- You may have heard of double taxation. Double taxation can occur when corporate profits are taxed at the corporate level and are returned to investors as dividends to be taxed again as individual income. The simple solution is for the corporation not to pay dividends. There are plenty of other ways to get money out of the corporation. You can pay yourself whatever wage you want. You can have the corporation reimburse you for expenses. The corporation can spend its money on anything the owners of the corporation want. It doesn’t have to be deductible or even make sense.
- Corporations file their own separate tax return on IRS Form 1120 and report earnings and taxable profit or losses. This can be a disadvantage or an advantage depending on tax brackets.
- Regular Corporations must conduct shareholder and director meetings, elect a board of directors
CLOSE CORPORATION – Our Favorite!
Wyoming is one of the few states that realizes there are many corporations that are held by just one person or a small number of family members or individuals. Close corporations are regular business corporations that elect to operate in a more informal manner similar to partnerships. Regular business corporations must conduct shareholder and director meetings, elect a board of directors, and provide shareholders with written proposals for any major corporate action to be voted on in the annual meetings. Close corporations usually do not hold annual meetings because the same people are shareholders and managers of the corporation or they see each other regularly. They do not need an “official” meeting to talk to themselves. A Board of Directors is also not required and there is much less formal paperwork required for ongoing operations.
- Abbreviated governance–Shareholders may agree in writing to treat the corporation as a partnership, operate without a board of directors, dispense with annual meetings, and make a shareholder agreement. (Note this must appear in the Articles of Incorporation.)
- Limited liability–Shareholders enjoy the same personal liability protection as regular corporations even though they relax corporate formalities in operations.
- Ease of operation–Operates like a sole proprietor or partnership without the formality required in regular corporations where hundreds of shareholders must receive information and vote.
- Buy-out provisions–Shareholder agreement can guarantee who may buy out a shareholder who wants to sellout or is deceased.
- Income is taxable to the corporation and not shareholders.
- A close corporation can be changed to a regular corporation at anytime with shareholder approval. As your company grows you can switch and then have an unlimited number of stockholders or even take your company public.
- A Wyoming Close corporation pays NO state income tax.
- Limited shareholders–Close corporations may not have more than 35 shareholders.
We believe Close Corporations are the very best vehicle for small and medium business. In return for its simplicity you are limited to 35 shareholders. If the time comes where you need to have more shareholders it is simple to change to a regular C-corporation.
Limited Liability Company or LLC
A LLC is basically a partnership with the liability protection of a corporation. A Limited Liability Company (LLC) passes gains or losses, credits or deductions, on to the members of the LLC in the same manner that partnerships are taxed. Individual members may benefit from a reduction in their taxable income if the corporation operates at a loss. Despite their unique tax treatment, LLC’s maintain full corporate attributes like limited liability. Unlike corporations with shareholders, LLCs have members. A managing member runs the LLC.
- Corporate attributes–offers members limited personal liability, the same as a C corporation offers.
- LLC’s may operate at a loss in their first years. Members may benefit from a reduction in their personal taxable income by receiving their share of corporate losses.
- Corporation continuity – life of a LLC has a set ending date.
- A Wyoming LLC provides no tax savings if you live in a state with a personal income tax. All income of the LLC flows though to members and is reported on form 1040
The main differences between a regular LLC and a Close LLC is there is a restriction on the selling of a member’s shares. A member must offer the shares, for sale, to the other member(s) of the LLC, before they can be sold to anyone else. All members also must approve of the sale of shares. This works well in a closely held family company, were the parents want to make sure that the children can not sell part of the company to outsiders.
A Close LLC is not required to hold annual meetings, unless requested by a member.
The Close Limited Liability Company Supplement, articles of organization, and operating agreement of a close limited liability company may also restrict transfer of ownership interests, withdrawal or resignation from the company, return of capital contributions and dissolution of the company.
“S” – CORPORATION
“S” or also called Sub-S status for a corporation is a tax election taken by any regular C- corporation or close corporation which meets specific criteria. Domestic corporations having 100 or fewer shareholders all of the same class of stock who are citizens of the U.S. or resident aliens may elect to pass gains or losses, credits or deductions, on to shareholders in much the same manner that partnerships are taxes. Individual shareholders may benefit from a reduction in their taxable income if the corporation operates at a loss. Despite their unique tax treatment, “S” corporations maintain full corporate attributes like limited liability and continuity of life.
S-Corporations and be converted easily at any time to a regular corporation.
If you live in a state with a personal income tax a “S” corporation would defeat the purpose of a Wyoming corporation to avoid taxes. All of the S-corporations income is passed directly to shareholders for taxation.
- Limited shareholders–no more than 100 shareholders.
- Must have only one class of stock such as common, but may have voting and non-voting.
- Citizen shareholders–must have shareholders who are citizens of the U.S. or resident aliens.
- All shareholders must consent to “S” corporation status.
- S- corporations may pass losses on to shareholders however shareholders must pay taxes on any income.